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Court Says Creditor Can Sue a Liquidating Trustee without Prior Permission

A bankruptcy court ruled that a creditor didn’t need to seek derivative standing to sue a liquidating trustee.  The creditor, himself a trustee of the debtor’s employee stock-option plan, had standing to sue without prior court permission because his suit wasn’t brought on behalf of the bankruptcy estate.  In re Foods, Inc., Case No. 14-02689, Adv. Pro. No. 21-3022, 2022 Bankr. LEXIS 2331 (Bankr. S.D. Iowa Aug. 23, 2022).

The suit followed the chapter 11 case of a grocery store chain, which had filed for bankruptcy in 2014 after a decrease in both the demand for its products and its profits.  The debtor confirmed a liquidating plan that set up a post-confirmation trust.

In 2016, the liquidating trustee brought an adversary proceeding against 10 of the debtor’s former directors and officers.  The complaint asserted claims for breach of fiduciary duty and alleged that the debtor had misrepresented and overvalued the company’s stock.  According to the complaint, this resulted in an overvaluation of the debtor’s employee stock option plan (the “ESOP”) and deepened the debtor’s insolvency.  The adversary proceeding continued until some of the defendants settled with the liquidating trustee and others filed for bankruptcy.

But the end of the lawsuit wasn’t the end of the matter.  In 2021, the trustee of the ESOP brought an adversary proceeding against the liquidating trustee.  This complaint alleged that the liquidating trustee had failed both to (i) keep a directors and officers’ insurance policy in effect and (ii) bring the suit against that former officers and directors before the policy lapsed.  

The liquidating trustee moved to dismiss the complaint on two grounds: (i) the lack of subject matter jurisdiction under FRCP 12(b)(1), and (ii) the failure to state a claim upon which relief could be granted under FRCP 12(b)(6).  The bankruptcy court rejected both arguments and allowed the case to proceed.  

The first issue was whether the ESOP trustee had standing.  The liquidating trustee argued that the suit was brought on behalf of all of the liquidation trust’s beneficiaries, and therefore the ESOP trustee was suing in a derivative capacity, thus requiring prior permission to bring the suit.  The court disagreed.

The court observed that the ESOP trustee was not suing on behalf of the bankruptcy estate because the liquidating trustee was not a chapter 7 or 11 trustee.  The court noted that “[u]pon plan confirmation the bankruptcy estate ceases to exist.  ‘All estate property is vested in the debtor at confirmation, except as the plan specifically provides otherwise.’”  In re Foods, Inc., 2022 Bankr. LEXIS 2331, at *6 (quoting In re Ernst, 45 B.R. 700, 702 (Bankr. D. Minn. 1985)).

The court stated that unlike chapter 7 and 11 trustees, the liquidating trustee derived his authority from the liquidating trust agreement.  In contrast, chapter 7 and 11 trustees are appointed by the United States Trustee and pursuant to the Bankruptcy Code.

The court also observed the ESOP trustee’s complaint “does not seek to litigate any causes of actions on behalf of the bankruptcy estate, or the Liquidating Trust, related to the estate assets of actionable conduct against the Debtor’s officers and directors or enforcement of the D&O policy.  Rather the allegations are focused upon [the liquidating trustee’s] conduct in not preserving the insurance policy for the benefit of creditors.”  Id. at *8.  Thus, the court ruled, the ESOP trustee could pursue direct (non-derivative) claims against the liquidating trustee.

Interestingly, nowhere in the court’s decision is mention of the Barton Doctrine, which bars suits against bankruptcy trustees absent court permission.  The Doctrine dates back to Barton v. Barbour, 104 U.S. 126 (1881), where the Supreme Court ruled that court permission was needed for a party to sue a receiver.  Since then, courts have extended the Doctrine’s application to chapter 7 and 11 trustees and, in some cases, to liquidating trustees. 

Once standing was established, the court’s analysis of the 12(b)(6) argument was straightforward.   The court reviewed the complaint to determine if it was “sufficient on its face to raise a claim.”  Id. at *12.  The complaint alleged that the liquidating trustee “did not meet the standards under the common law as a trustee because: 1) the actions against Debtor’s former officers and directors were filed after the run-off insurance coverage lapsed or 2) [the liquidating trustee] failed to purchase an additional endorsement to extend the run-off coverage so that claims against the insurance policy could be made.”  Id. at *11-12.  As a result, the court ruled that the complaint stated a claim for which relief could be granted and denied the liquidating trustee’s motion to dismiss.